Anacomp at 1x earnings?

Sometimes it seems pointless trolling through tiny little no-name stocks looking for value.  A friend sent me an email recently saying that one thing that stuck out to him from the Buffett shareholder letters was that Buffett found drop-dead cheap ideas.  There wasn't any question that the things he was buying at the time were undervalued, it was so obvious all one had to do was buy and wait.  The company in today's post illustrates that there is significant value in unlisted companies, and that that drop-dead cheap companies still exist in today's market.

Explaining why Anacomp is cheap could easily be done on a napkin, if I were to write it on a napkin I'd write:

• Earned $.75 p/s last year, trades at $.75, 1x earnings
• $.61 p/s in FCF, 1.22x FCF
• $27 p/s in NOLs
• Deleveraging, building cash

First off Anacomp (ANCPA) is not a Chinese company, a reverse merger or anything shady as far as I can tell.  For curious readers the company's RFP's are available online, I was able to find some contracts in a government database as well.  The company is simply small and forgotten, trading far on the fringes of the market.

Anacomp is a document management company that's been in existence for 40 years.  The company's business is fairly simple, they scan in documents for customers and provide indexing and online document management services.  This is especially important for customers that are paper heavy, such as the government (who happens to be their largest customer.)  The company provides a valuable service in centralizing document digitalization, storage, and retrieval.  Clients can continue to be paper heavy but offer digital copies if necessary.  The company has two locations, one in Washington DC, the other in Southern California.

With a company trading at 1x earnings not much time needs to be spent determining that they're actually cheap.  Most research time should be spent evaluating what could go wrong, and if the price is low enough to compensate for any problems, known and unknown.

Anacomp is far from perfect, there is plenty of hair on this investment, but go back and read the little thesis again before each hairy item, they look a little less scary each time.  I'm going to go through the biggest issues I see one by one and knock them out.

All earnings, no assets - This isn't the biggest ding against the company, but it's a fairly large one.  The company has $4.3m in cash, and $2.2m in accounts receivable, current assets are $7.1m.  The company's current liabilities aren't all that terrible either at $2.5m.  The company has a pension and some debt that negate any positive value from their assets.  Total shareholder deficit is -$759,000.

The company has something peculiar with regards to their pension, the pension that's zero-ing out assets.  The pension is held for an in-active German subsidiary with a liability of $8.8m.  The pension has $5.8m in assets, mostly bills, bonds and insurance, which is disallowed by GAAP.  It appears that the company purchased annuities for some pensioners, that's what the insurance contracts are.  Under GAAP insurance isn't a valid pension asset, so the company appears to have a $8m pension shortfall even though they have taken care of most pensioners via annuities.  The real shortfall is $3m, although it could be considerably less.  The company's discount rate and expected return are both very low at 3.5%.

Debt - I alluded to this in the above bullet point.  The company has $3.6m in debt related to an acquisition.  It appears the company struggled to integrate the acquisition which led to operating performance problems.  The company had trouble repaying the promissory note on the original repayment schedule.  They were able to re-negotiate and extend the terms twice.  The company is now on track, paying down the debt, and appears able to pay it off with cash on hand currently.

Earnings clarity - The US Government accounts for 99% of the company's business.  According to the notes it appears that sales are locked up for the next two years.  If this is true that the next two years look like the most recent this would mean that the company will have earned over $4m, repaid most of their debt, and would have a positive book value of over $3m in 2015.

The biggest issue investors have is there is no earnings clarity beyond two years.  If the government decides to not renew, Anacomp will be generating losses and looking to hit up the credit markets to survive.  Fortunately this dire scenario presumes that management is completely idle and happy to milk the cash cow for two more years before deciding their next steps.  Since the company's annual report came out there have been a flurry of news items on the company's website.  They inked a five year deal with the VA, earned an award with Northrup Grumman and hired a healthcare executive to sell to health organizations.

Instead of sitting idle management appears to be pro-active in searching out new business opportunities.  I don't know if it'll be enough to replace the current revenue and earnings, but with two years of runway there is plenty of time.

Final Thoughts

The question investors need to ask themselves is whether at 1x earnings Anacomp is cheap enough to compensate for all of the above risk factors?  I think it is, my margin of safety is in the low earnings multiple.  If earnings drop 50% I still own a stock with a P/E of 2.  If earnings drop 75% the stock would have a P/E of 4x.  It would be hard for anyone to argue that at a P/E of 4x a company is fairly valued.

I didn't discuss the NOLs in my post outside of the brief mention in the thesis.  The company won't be paying taxes on any earnings for a very long time, so long that they most likely won't ever use them up unless earnings significantly grow.  The bonus here is that management might find a way to structure a deal so that those NOLs take on tangible value.  If that were the case there is a lot of room for this to be re-valued.

I have no idea what a fair value for Anacomp is, but I know it's not 1x earnings, even 5x earnings seems low.  If the market ever revalues this company, even just a little bit investors could experience some massive gains.  I'm along for the ride on this one..

Talk to Nate

Disclosure: Long Anacomp